Bitcoin Part 2 – The Legacy

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tl;dr – Bitcoin will not survive long-term. The value of Bitcoins will ultimately go to ~0. However, the underlying technology and protocols are a testbed/prototype for future implementations of distributed, decentralised financial technologies.

“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.” — F. Scott Fitgerald

I previously wrote about Bitcoin’s flaws. However, despite the fact that I doubt Bitcoin will succeed as a currency, I expect that it will leave a positive legacy. For all its flaws, Bitcoin has garnered far more usage and media attention than any previous cryptocurrency. That will have long-term ramifications, for a number of reasons.

Firstly, Bitcoin has raised general awareness of, and interest in, decentralised technologies. Following Napster’s demise, the phrase “peer-to-peer” became synonymous with file-sharing and tainted by association with copyright violation and piracy. Despite p2p technologies’ huge potential, centralised services and walled gardens like Facebook and Twitter prevailed. The Internet was supposed to bring about an era of disintermediation but, in fact, it has given rise to a new generation of middlemen, who are larger and more powerful than the old, thanks to a virtuous combination of network effects and economies of scale, are larger and more powerful.

The Bitcoin protocol demonstrates the vast potential that p2p technology offers and has introduced many people to the concept of a service or product that doesn’t depend on a centralised point of control and authority. As well as the inevitable slew of Bitcoin clones, we’re seeing people building tools and services on top of the Bitcoin blockchain (e.g. providing better privacyproof of a document’s existence and timestamping).

Over time, we’ll see more development of standalone products and services that don’t rely on the Bitcoin blockchain, like Ripple‘s implementation of trust chains and Ethereum‘s smart contracts.  In effect, Bitcoin has sparked more R&D into p2p technologies and that can only be a good thing. 

Secondly, Bitcoin has piqued interest in alternative financial technologies (fintech). The combination of a gold rush mentality and populist antipathy towards banks is fertile ground for eager young startup founders. As a result, a slew of Bitcoin startups have attracted VC funding. They are all set for a rude awakening as they discover that fintech is much more difficult than they anticipated. Hacking something quick’n’dirty together and winging it as you hustle to get as many users as you can before demo day has become the standard MO for Silicon Valley startups but it’s a risky approach to take when you’re dealing with people’s money.

Running financial services also demands a certain amount of operational and financial rigour, which is not always present in startups run by inexperienced, young programmers. We’re likely to see a number of high-profile, MtGOX-style implosions, and it wouldn’t surprise me if both founders and investors are targeted by lawsuits from customers left out of pocket. The end result will be a more experienced and wiser VC community, with a better appreciation for the complexities and nuances of fintech.

Thirdly, the hype around Bitcoin has spurred regulators  and tax authorities to clarify virtual currencies’ legal and tax status. In the US, FinCEN has issued guidance on how the regulations governing money services businesses will apply to virtual currencies while, in the UK, HMRC has published a brief on the tax treatment of activities involving Bitcoin and other similar cryptocurrencies. Banks currently steer well clear of Bitcoin for fear of falling foul of anti-money launder legislation. Clarity on the regulatory treatment of virtual currencies will legitimise them and make banks feel more comfortable about providing banking services to businesses dealing with virtual currencies. That will make it far easier to buy and sell virtual currencies, and expand the addressable market for products and services based on them. 

Finally, the prospect of a self-sustaining “cryptoconomy” has raised the possibility of new economic and business models that don’t rely on fiat currencies and, therefore, aren’t subjected to the limitations inherent in fiat currency-denominated models. The best example of this is ASICMINER, which raised capital to fund the production of dedicated ASICs for Bitcoin mining by conducting an online IPO in August 2012, creating a virtual hardware company that operates its own Bitcoin mining facility and sells mining hardware to others. Profits are distributed to shareholders, paid in bitcoins. Nobody knows who’s behind ASICMINER (its “CEO” posts on the BitcoinTalk forum under the handle friedcat) but those who “invested” in its IPO  don’t care – the shares currently sell for more than 4x their flotation price (as denominated in Bitcoins, which have themselves increased in value ~26x since the IPO) and have yielded weekly dividends for over a year now.

Other companies have conducted similar IPOs but most have failed or turned out to be frauds (e.g. the Bitcoin Savings & Trust ponzi scheme) and the first generation of Bitcoin-based virtual stock exchanges have mostly shut down, rather than face of prosecution for violating anti-money laundering and securities laws. One notable exception is Havelock Investments, which is domiciled in Panama and offers funds, securities and derivatives based on (and denominated in) Bitcoin.

As the regulatory environment becomes less murky, we’re likely to see a new generation of exchanges and similar businesses, operating within a more confidence-inspiring legal and regulatory regime. In my opinion, that is the point at which we are likely to start seeing some really interesting innovation. For example, companies could raise money by issuing “bitshares” that can be traded online without the need for a centralised stock exchange, or raise debt financing by issuing “crypto-bonds”. Banks could begin exploring new operating models, such as replacing deposits with a virtual currency that can be used for online transactions and ultimately redeemed (i.e. sold back to the bank) when a holder needs to convert it back to fiat (this is effectively how M-PESA currently operates in Kenya).

The whole capital markets and financial services industry could undergo a revolution and that is what I think Bitcoin’s ultimate legacy will be. As Napster is to Spotify, Bitcoin will be to the next generation of financial services.

Written by jackgavigan

March 21, 2014 at 11:37 am

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